On Thursday, the UK central bank will announce its interest rate decision and is expected to deliver another 25 bps rate hike, raising rates to 4.75%. Some analysts even expect a 50 bps rate hike after the latest inflation shock. Core CPI accelerated to 7.1% yoy in May and with wage growth accelerating to 7.2% yoy last week, the BoE may be forced to respond. The pound will remain extremely volatile during the BoE policy announcements.
The BoE will be delivering its 13th consecutive rate hike this Thursday, as it continues fighting persistently high inflation. The central bank has faced criticism for its failure to keep inflation close to its 2% target, after it kept rates at record lows until December 2021. In this article, we will look at inflation in the UK and how markets expect the BoE to act to bring inflation down to its desired target of 2%.
Even though inflation dropped from the previous double-digit figures, the UK’s consumer price inflation remains one of the highest when compared to other major economies. On Thursday, because Governor Andrew Bailey will not give a press conference or provide any updated economic projections, market participants will focus on the language in the BoE’s monetary policy statement for fresh signals on its rate hike outlook.
The UK inflation report for May was disappointing and alarming, especially just before the Bank of England heads into its June decision on Thursday. Inflation remained unchanged at 8.7% with core inflation (excluding food and energy) and services inflation jumping back higher.
Economists believe the BoE would need to respond clearly and show that it is determined to bring inflation back under control and that it has a solid strategy to do that.
With private sector wages rising and firms passing their costs on consumers, markets expect inflation to rise further and potentially become entrenched. The bank has a difficult task ahead. Brexit has added to the economic problems, as it has led to a decline in output and competition, and with the pandemic and the war in Ukraine, inflation has become more vulnerable. The BoE has repeatedly underestimated the extent of the tightening that was needed to control inflation, which has added to the problem.
How should the BoE act?
A surprise 50 basis point rise, rather than the expected 25bp increase may be a start but such a hike, if it is isolated, may not have lasting effects. The BoE could begin with 50bp hike and then proceed with smaller ones of 25bp. Alternatively, it could proceed with a series of 25bp rises, with the possibility of a 50bps hike if inflation persists further, or slow down to one increase every other meeting if the data turns positive.
This is why, as the Financial Times have pointed out, the BoE needs to act in a more decisive manner and deliver a clear and committed strategy where interest rate decisions are the result of their strategy and not a substitute for not having one.
A clear message from the BoE that it will act decisively to bring inflation back to target may do the trick. The bank should indicate that it will take appropriate action and conduct policy to change inflation in the next 12-18 months and push it back towards its 2% target.
While a 50 bps rate hike would be a hawkish surprise, it is not impossible and would help strengthen the pound significantly and push GBP/USD higher.
Inflation and wage inflation have remained persistently high since the last policy meeting and with the BoE’s forecasts about inflation falling from April proven to be inaccurate, the BoE needs to take a more decisive action, acknowledge how stubbornly high inflation remains and outline a clear course of action.